Dividing free and paid features in “freemium” products

One of the most difficult decisions to make when developing a “freemium” product is how to divide the product between free and paid features.

Assume you’ve come up with the “ultimate” product – the complete set of product features including both free and paid versions. Given this, many people think they need to make the following trade off:

1) more features in free version –> more users
2) fewer features in free version –> higher conversion rate from free to paid

So for example, if your consumer storage software gives away tons of free storage, the assumption is you will get more users but a lower conversion rate, as compared to a competitive product that gives away less free storage.

Actually this not the whole story, because tilting toward #2 – more features in the paid version – opens up new marketing channels that can actually get you more users. If you have a compelling paid product that isn’t undermined by a nearly as compelling free product, you can potentially profitably market through affiliate networks, SEM, display ads, bizdev partnerships and so forth. Lots of websites that reach large user bases are only interested in promoting paid products. For example, from my experience, OEMs (PC makers like Dell & HP) are only interested in offering security software that they can charge for in order to generate additional revenue.

In terms of the user experience, it is often very difficult to draw the line. In the old shareware days, software would nag you with popups or expire after a certain number of days. I don’t like either of these approaches. Nagging is obviously just annoying. And expiration schemes end up tossing out users who are potential future customers. Why not keep them around and preserve future opportunities to offer them something they find useful enough to buy?

The ideal division allows the free product to be an independently useful, non-annoying, non-expiring standalone product, while still leaving room for the paid version to offer sufficient additional value that some acceptable percentage of your users will upgrade.

Some products are fortunate enough to have a natural division point. For example, in security software, “remedial” products like anti-virus and anti-spyware often give away a free scan, and charge for clean up if your PC is infected. What’s nice about this division is that the free product has non-annoying, genuine standalone value, and if you actually do have an infection the upgrade is extremely compelling. (The bad news is that this division encouraged companies to hype the risks of innocuous things like browser cookies).

Preventive security products are trickier to divide than remedial security products. Preventive security products include firewalls like ZoneAlarm and my prior startup, SiteAdvisor (and now SiteAdvisor competitors like Norton’s SafeWeb and Trend Micro’s TrendProtect). The problem with preventative security products is that the only features you can remove end up opening up a vulnerability, which just feels like a huge disservice to the user.

Skype figured out a nice division point: free for Skype-to-Skype calls, pay for calls to regular phones. It’s not clear how sustainable this is as the cost of long distance drops to zero and the distinction between software phones and “regular” phones goes away.

Online storage products usually divide things by the amount of storage. The nice thing about this is 1) you can test a bunch of different prices/storage levels, 2) you get to have a free version plus multiple tiers of paid, which means your pricing can more granularly track customers’ willingness-to-pay. The goal of all revenue maximizing pricing structures is to minimize what economists call “consumer surplus.” Since you can’t gaze into the mind of the user to see what she is willing to pay, and attempts at explicit price discrimination are usually met with outrage, you have to look for proxies for willingness-to-pay. With stock quotes, professionals can’t wait 15 minutes. With books, avid readers don’t want to wait for the paperback version. With databases, wealthier companies have more servers. And with online storage, professionals and hardcore consumers are generally more likely to need more storage space.

The New York Times’ TimesSelect was one of the more interesting attempts at the freemium model. It was free to read the regular news but you had to pay for the op-eds. Personally I usually read one or two of their op-eds every day, but part of the attraction is that I know my friends do and someone will say “Did you read the Krugman piece today?” and then we might chat about it. So in a way op-ed’s have network effects. Putting them behind a paywall doesn’t just reduce their readership, it reduces their influence – the very influence that compels people to read them in the first place.

A final thought: when in doubt, err on the side of putting more features on the paid side of the divide. It’s easy to add features to the free side; however, removing features from the free side is a recipe for trouble.